Whether you do stocks, crypto, or other assets, taxes are part of the trade. If you ignore costs, your investments will underperform. But that doesn’t mean you cannot save on your annual bill (or avoid most of them).
Regardless of your income level and trading frequency, there are ways to pay less to the IRS legally (sometimes even 0%). If you want to make your portfolio more tax-efficient, learn more about the following strategies.
- 5 Strategies for Tax-Efficient Investing
- 7 Tax-Reduction Alternatives
- How to Invest and Not Worry About Tax
5 Strategies for Tax-Efficient Investing
#1 Capital Loss Offset
The IRS wants 0 to 20% of whatever you earn on long-term gains. What happens if you earn a lot this year and want to sell early? It will count as income tax, which may put you in a higher bracket.
The only time you pay no taxes is when you lose money. All investors do sooner or later. The difference is, you can choose what and when to sell.
Suppose your portfolio has appreciated, but there are also some losing stocks. If you want to withdraw some profits, you can minimize taxes by selling the losers. If you profit $5000 and lose $4,000, only $1000 contributes to your income.
Does it mean you lost money? Not always.
Maybe that’s $4K you lost years ago but decided to hold. If you earned $4,000 from another trade and sell both at once, you owe $0 tax. It doesn’t matter if you kept the profitable stock for <12 months.
Note: If you buy the same/similar stock within 30 days of the stop-loss order, the IRS will revoke the loss adjustment (aka wash sales). If you sold $4K and want to buy back, wait 31 days to avoid paying taxes on the loss.
#2 Tax-Exempt Securities
Investing in government securities improves the country’s liquidity. Whenever you invest in Treasury Bonds, T-Bills, and some stocks, you pay no taxes on a local/state/federal level.
While bonds are more popular, any company that invests in the US treasury could be tax-exempt (because the Governments can’t tax themselves). Securities may include mutual funds, ETFs, and retirement plans.
#3 Low Tax Brackets
Unless you need emergency money, you stay in a low tax bracket by timing your investment sales. At the same time, you want to max out the income capacity for your tax percentage (e.g., 12% for <$40,125 of annual income, $80,250 if MFJ) by the end of the tax year.
If the term is about to end, you have lots of money invested, and there’s still enough margin in your tax bracket, consider withdrawing. Especially if you believe your income will increase over time.
What happens if you already belong to a high-income bracket? You can “get rid of” some money by sending it to other accounts with your family and friends. When the tax year ends, you can make yourself a loan to get back those amounts.
If your investments earned more than you expected, reinvesting is a simple way to defer taxes.
#4 Retirement Accounts
Retirement accounts offer a tax advantage to profit from compound interest. If you are at the bottom of your tax bracket, you can drop to a lower one by investing the rest in your 401K/IRAs. If you’re already investing, there’s no reason not to max out the yearly contributions.
Retirement money doesn’t offer liquidity until you are 59 1/2. So if you’re avoiding taxes as a way to grow money faster, retirement investing makes sense after trying everything else.
#5 Hold Until Tax Discount
If you can’t avoid taxes, wait a year until the IRS considers your items as long-term investments. Unless your annual taxable income exceeds $40,000, you pay 0% in capital gains tax. You pay 15% when earning below $248,300 and 20% when above.
If you don’t qualify for 0%, you can sell your stocks to a friend or family member (as a gift) who earns <$40K/year.
7 Tax-Reduction Alternatives
#1 Annual Stock Gifts
If you don’t want to include some stocks in your tax bill, you can send them to someone in your household as a gift. It’s tax-free up to $15K per person every year. As for 2021, the lifetime exclusion is $11.7 million (18% to 40% depending on the excess amount).
So you can send stock to your child’s custodial account. However, it’s only helpful for hiding securities from your portfolio, as child accounts have smaller tax brackets:
- If you sell the stock after holding long-term, capital gains tax applies (0% under $2,650, 15% under $12,950, 20% if above)
- If you sell before one year, it counts as ordinary income
There’s a $1,100 yearly deduction, and the minimum rate is 10% for <$2,650 amounts (if your investment earns passive income or you sell it). It can be as high as 37% if it gets over $12,750 per year.
Gifts don’t qualify as income, thankfully.
#2 Qualified Business Income Deduction (QBI)
Unless you receive income from C Corporations, you may qualify for a 20% tax discount.
To qualify for QBI, your taxable income must fall below $164,900/year ($329,800 if MJF). This limit doesn’t apply when belonging to qualified businesses:
- Real property trades
- Farming businesses
- Electrical energy, gas, water, sewage, disposal services
- Patrons of agricultural cooperatives
Before applying, learn about the categories excluded for QBI (consulting, investing, health)
#3 Direct Stock Donations
Are you looking to donate your stock profits? The government rewards philanthropists by lowering their taxes. You don’t need to pay capital gains tax when selling plus other fees when donating.
Instead of paying 20%, you give that amount to the charity. You can donate the stock directly or join a donor-advised fund.
#4 Achieve Trader Tax Status (TTS)
Trading doesn’t sound tax-efficient because you don’t qualify for long-term discounts. That’s not the case of TTS traders:
- Easier to qualify for QBIs (even though the program excludes investing)
- $3,000 yearly deduction from capital gains
- Exemption from wash sale loss adjustments
- Excluded from self-employed taxes
- Qualifies for all tax benefits of owning a trading business
While there are many requirements to qualify for TTS, it’s not easy to verify them. The three most likely requirements include:
- High-frequency trading (~60 orders per month)
- Trade 3 out of 4 trading days (~4-day minimum workweek)
- Sell traded assets in under 31 days
#5 Tax-Advantaged Retirement Plans
If you work for the local/state government, you could qualify for a 457b plan.
Unlike traditional 401Ks, 457Bs allow you to withdraw funds before retirement. You don’t wait until you’re 59 and a half to get your money out. If the portfolio grows enough, you can withdraw as soon as today for no penalties.
When withdrawing, you pay tax both on the tax-deferred investment and the accrued interest.
#6 Self-Employment Deductibles
If you want to invest for a living, you might prefer the benefits of self-employment. Traditional employees share SE taxes with employers. And while SE workers pay it all themselves, they also get discounts on 10+ business expenses:
- Internet and phone bill
- Health insurance
- Home office
- Office rent
- Startup costs
- Vehicle use
- Interest rates
If that’s something you want, it might be worth the risk of self-employment (and the variable income).
#7 Offshore Banking
A quick fix to tax issues is to move to a low-tax state or country. But what if you could enjoy those tax havens while keeping the income level from a country like the USA? Consider offshore banking.
All you need is to find a place that (a) doesn’t tax international transactions, (b) uses lower tax rates, or (c) has fewer regulations. The Cayman Islands, Switzerland, and United Arab Emirates (UAE) fit in these descriptions.
Suppose you open an account in UAE (generally 0% tax). You can sell your investments to your UAE account. And if you want to use the money in the US, you borrow it from your UAE “lender” account.
Loans don’t count as income.
While it’s not as easy as it sounds, that’s how you’ll save the most.
How to Invest and Not Worry About Tax
The investor’s dream is to make so much money so that you don’t worry about it. How can you expect to achieve financial freedom when taxes get in the way of investing?
When earning low annual returns, the tax cut forces you to save money in other ways. So while you might make money, you keep as much as you should. Ask yourself: what performance do you need to consider an asset successful after taxes?
Would you look for low-return companies or research others with higher rewards? All the time, you can find companies that grow exponentially. Is it worth the risk?
If you think you’d leverage your money better without investing it, it might be time to find new securities. If you want to find opportunities and get in early, here’s a guide on how to research projects yourself.
If you prefer a passive approach, hold assets for over 12+ months to benefit from 0-20% CGTs. Because you have to hold, you’ll be more selective with your trades. And in the long-term, your investment has more chance to appreciate.
To focus 100% on your strategy, you might want to work with a tax professional. They work full time to learn the latest changes and how you can take advantage. The peace of mind may be worth the cost.